California Companies Brace For Litigation After Labor Bill

California employers say a new measure that could make it harder for them to classify their workers as independent contractors would have ripple effects across the gig economy and beyond, prompting new litigation, investor concerns, and uncertainty about whether existing business models will be upended.

The measure, Assembly Bill 5 or A.B. 5, would codify a more rigid test for employers to classify workers as independent contractors instead of employees. Known as the “ABC test,” it would create a more difficult landscape for companies that rely on contractors. The distinction is key because employees are entitled to benefits such as minimum wage, business expenses, and overtime, unlike a contractor.

It’s not just the app-based companies, such as Uber Technologies Inc., Postmates, Inc., and Lyft, Inc., that would face legal hurdles to meet that standard but also franchises, construction workers, truckers, software coders, janitors, journalists, and exotic dancers. Nationwide, there has been a steady rise in independent contracting jobs as companies look to shed labor costs and liability.

“This will affect almost all industries. We’ve already seen an uptick in litigation on this particular issue and we’ll see a lot more,” said Katherine Catlos, a partner in San Francisco with Kaufman Dolowich & Voluck. “A.B. 5 is a Band-aid over an already complex legal analysis. It may appear simple, but it’s not, and each factor below has a wealth of seemingly conflicting case law and differing public policies depending on the industry and worker at stake.”

The new standard, which has yet to be signed by California’s governor, requires companies to clear three hurdles to classify a worker as a contractor: weighing the employer’s control over how the work is performed; whether the services are within the normal course of business; and whether the workers have an independently established role. These factors could upend business models that rely on contractors.

California companies now face a choice: Comply and rejigger their business models, or risk being sued by its workers or face potential action from state or city officials. Supporters say A.B. 5 will help prevent businesses from leaning on contractors to cut down on costs, and stop disenfranchising workers by keeping them from the benefits they are entitled to.

Unions backed the measure as a step toward needed change. A.B. 5 puts an end to exploitative behavior of companies like Uber and Lyft, said John Costa, international president of the Amalgamated Transit Union.

Litigation Begins

Only a day after the measure passed the state legislature, a lawsuit was filed against Uber Technologies for wage violations for misclassifying its drivers. The complaint points to the bill and argues it was specifically aimed at such business practices. Uber’s chief litigation officer, Tony West, released a statement telegraphing that the gig economy will continue to argue that it can still legally rely on contractors, even under the stricter ABC test.

“Contrary to some of the rhetoric we’ve heard, AB5 does not automatically reclassify any rideshare drivers from independent contractors to employees,” West said. “AB5 does not provide drivers with benefits, nor does it give drivers the right to organize. In fact, the bill currently says nothing about rideshare drivers.”

Boston-based attorney Shannon Liss-Riordan filed the lawsuit on behalf of Uber drivers immediately after West’s announcement. She said the case against Uber will have wide effects on other gig businesses.

“It’s somewhat stunning that a company would be so defiant, with a state that has strongly stated that workers need to be protected,” Liss-Riordan said. “Uber has known it won’t satisfy the ABC test, it spent so much money to lobby and block AB 5, and it didn’t get that either. Then they say, ‘We still aren’t going to follow it.’ That calls out for action.”

Giving workers in California employee status and benefits would cost Uber and Lyft an additional $2,000 to $3,600 per driver annually, according to research from Barclays Plc and Macquarie Capital. That would be as much as $500 million for Uber in the state each year.

Several states—including New Jersey, Massachusetts and Connecticut—already have worker classification tests in place. California often leads the country with progressive labor laws, and employment attorneys fear others will follow. New York’s governor has said he’s interested in exploring the test, and several other legislatures have proposed similar measures.

In New Jersey, which has the same three-part test as California, a state appeals court sided with a law firm and said a paralegal could be classified as a contractor under the ABC test. The case shows that under the right set of circumstances, an employer can prevail even under the tougher test, Mark Tabakma, an attorney with Fox Rothschild, wrote in a recent client advisory.

Investors Wary

Still, many management-side attorneys say California’s bill is unwieldy and leaves open questions for companies. Certain industries are exempted, including insurance agents, physicians and engineers.

For years, companies focused on how much control they had over workers, rather than the other factors laid out in the ABC test, said James Fessenden, a partner in San Diego with Fisher Phillips. This is how the gig economy businesses built their models, and now they will have to press a legal theory to keep their businesses in place, he said. Other industries also are scrambling to reassess their workforce.

Investors are taking note of the worker reclassification and say it could be a risk factor when deciding which businesses to fund, said Littler Mendelson shareholder Michael Lotito, head of the Workplace Policy Institute at the firm. He said investors were attracted to the innovative model adopted by gig companies.

“There is going to be a lot of ambiguity. This is an arbitrary list of ins and outs. There will be enormous amounts of litigation,” Lotito said. “Is this the tipping point? The California economic miracle of the last 10 years, driven by private equity and investment vehicles don’t want to invest in deals because of all the uncertainty.”